When the 50 Percent Penalty Applies During Offshore Voluntary Disclosure

The Offshore Voluntary Disclosure Program (OVDP) normally comes along with an “offshore penalty” equal to 27.5 percent of the highest aggregate account balance of the previously unreported foreign financial assets. However, the penalty is increased to 50 percent for taxpayers who have accounts at foreign financial institutions that are under investigation by the IRS or Department of Justice, or who are cooperating with the U.S. government regarding accounts held by U.S. persons. These foreign financial institutions have been referred to as “bad banks”, and the list of bad banks has continued to grow each year.

How the 50 Percent Penalty Works

Not only does a taxpayer face a 50 percent offshore penalty for any assets held at a bad bank, the taxpayer must pay the 50 percent penalty on all of their unreported foreign assets. For example, a taxpayer with a $10,000 account at a bad bank and $500,000 at a foreign bank that is not under investigation will be subject to the 50 percent penalty on the total of both accounts, despite the fact that the majority of their funds are held at a bank that is not under investigation.

The increased penalty applies because once it has been publicly disclosed that a bank is under investigation or cooperating with authorities, account holders are effectively on notice that their foreign account information is being looked at by the IRS or DOJ, and that their failure to file FBARs or form 8938 will be discovered in due time.

Although the 50 percent penalty may seem daunting, it still provides a viable option for taxpayers with willful FBAR violations who want to avoid the risk of possible criminal prosecution, in addition to severe civil penalties which can exceed more than 100 percent of the account balances. Individual taxpayers who are under examination are not eligible for the OVDP or Streamline Filing Compliance Procedures, regardless of whether the examination is related to their unreported foreign accounts.

Taxpayers whose failure to file FBARs was non-willful can still use the Streamlined Filing Compliance Procedures even if they have accounts at one of the bad banks. The increased penalty only applies if there was both a willful violation and an unreported account at a bad bank. Anyone with unreported foreign accounts at one of the bad banks should therefore consult with an offshore disclosure attorney to closely examine the presence of willfulness because the difference between using OVDP and the Streamlined Procedures will be even larger than usual in their case.